As Adams Street Partners gets more active in Southeast Asia, it looks to set up country-specific funds in the region going forward.
“There are certain countries in Southeast Asia where the economy is large enough and the private equity industry is deep enough for us to be able to do this successfully,” Sunil Mishra, partner at the US-based investment manager’s Singapore office, told DealStreetAsia in an interview.
“Vietnam and Indonesia are pretty uniquely placed … I think we can see ourselves doing country-focused funds in these two markets,” he added.
Investing in fund managers, private credit, and secondaries, as well as directly into operating companies, the firm believes Southeast Asia is poised to grow across all of these strategies.
“Southeast Asia is making a good and steady progress, and we expect to be active on multiple fronts in this market,” said Mishra.
Last year, the firm invested in Indonesia-headquartered East Ventures’s eighth fund, marking its first funding in the venture capital space in the region. So far, it has primarily backed growth and buyout funds.
“As the ecosystem expands and the market matures, we will likely continue to add names to our roster of managers,” Mishra added.
In June 2020, DealStreetAsia had reported that Adams Street Partners was seeking to raise up to $350 million for its Asia fund-of-funds. Its allocation to the region then stood at 9.3%.
While Mishra did not comment on fundraising or the performance of the firm’s overall investments in the region, he highlighted how exit avenues in Southeast Asia have expanded as local managers have matured.
Exits have been “strong enough that we remain interested in putting more capital into the region,” he opined.
Mishra will be speaking at DealStreetAsia’s Asia PE-VC Summit 2021, which will take place from September 28 to October 1.
Edited excerpts from an interview with Mishra:
What would you consider as the ‘sweet spot’ in Southeast Asia in terms of fund investments for Adams Street Partners?
Adams Street initially started investing in regional funds in 2004 – the markets were very nascent then and we predominantly invested in Southeast Asia. In the early days of our investment programme, our exposure was in growth and buyout because there was very little high-quality venture activity. Over time, we have expanded our portfolio and have backed a range of funds that are pan-regional with a strong Southeast Asian presence. We have also invested in Southeast Asian private equity firms which focus on buyout and minority growth transactions. More recently, we have been adding some exposure to early-stage ventures, and have backed East Ventures as our first investment in the venture capital space. As the ecosystem expands and the market matures, we will likely continue to add names to our roster of managers.
Overall, Adams Street’s investment mandate is quite flexible and comprehensive. We can invest anywhere from early-stage funds to those [funds] as large as a couple of billion dollars. Going forward, we expect to look at country-specific funds as well. There are certain countries in Southeast Asia where the economy is large enough and the private equity industry is deep enough for us to be able to do this successfully. At this stage, Vietnam and Indonesia are pretty uniquely placed as large opportunity-set markets from private equity and venture capital perspective. I think we can see ourselves doing country-focused funds in those two markets. These market assessments are dynamic, and we revisit this every two-to-three years.
At the core of our investment mandate, we seek to work with general partners who have a proven history of finding interesting deals, significant experience working with founders and management teams, generating strong realized returns.
Your deals span diverse areas – you do primary investments, co-investments, private credit and secondaries. What will work best in Southeast Asia?
Essentially, we believe that all of our investment strategies work really well in Southeast Asia. Primary investments are probably one of the first strategies we lead within most markets. Generally, if there are good general partners, we feel confident that there will be high-quality co-investment, private credit, and secondary opportunities too.
Our aim is to understand if a particular private equity market, be it a country or the entire region, has the ability to support a long-term private capital industry. If this thesis holds true, we look for managers that inspire high levels of confidence in terms of skill, knowledge and ability to generate attractive returns over long periods of time. From there, we will find ways to work with them on secondaries and co-investments.
For all strategies, Southeast Asia is making good and steady progress, and we expect to be active on multiple fronts in this market.
Secondaries are gaining steam across APAC. In Southeast Asia, how is the strategy evolving? What is the risk-return profile?
In general, secondaries are usually attractive when private equity markets reach a certain size and scale. Without that, secondary markets are just highly opportunistic.
First, for secondary deal flow to be good in both quality and quantity, you need to have a certain level of primary market capitalisation. Southeast Asia is finally getting there. Second, a lot of institutional investors are still building their Southeast Asia exposure which means they are still adding exposure than selling.
We see two types of secondary deal flow in Southeast Asia. One is a GP-led transaction where a couple of assets are likely to take slightly longer to exit, but GPs think there is still a lot of value in them so will set up continuation vehicles. Then there are what we call non-traditional private equity LPs who have invested a lot more opportunistically – they may have a change in strategy, and want to get out of certain funds or the markets they have invested in.
Are continuation funds in Southeast Asia an indication of a poor exit environment in this region?
Continuation funds are set up when there is a difference in view in terms of the exit value between now and, let’s say, three years from now. For myriad reasons, some existing investors do not have the ability to hold for that long, so they’re looking to find new investors who are ready to back the GP and be part of the next chapter of value creation to those assets. This trend is quite global, and we are seeing the same in Southeast Asia now.
We will see more and more of that, especially in Southeast Asia where exit opportunities have been slightly fewer than other larger Asian markets with IPO exit options. The number of exits has still been limited, in terms of either companies being able to access IPOs or IPO markets being able to offer substantial liquidity options. We’ll probably see more people actively going to secondary markets to generate liquidity in their funds. This will improve the exit options for fund managers.
Given the challenges in assessing how a business will continue to perform, what should be done when expected valuations change in a secondary strategy? Will there be a possibility that a deal could collapse?
One of the merits of a secondary situation is that you are not just doing a blind pool investment but you are going in with pre-identified assets. The bid-ask spread can be very wide in certain cases, [and] a deal may not materialise.
However, in most situations, buyers would undertake very comprehensive due diligence to be able to agree on a price. This is different from a primary investment, where you do not know what you’re going to get eventually. In a secondary transaction, at least in continuation vehicles, you have very high visibility, sometimes almost 100% knowledge of the assets. GPs also have a history with the assets, which is an important criterion for a secondary buyer.
What about co-investments in the region?
As we are investing in all key markets in Asia, there is a high level of familiarity around fund investments and specific markets. From there onwards, our assessment [of co-investments] is highly standardised. It focuses on the quality of the business, quality of earnings, the value the sponsors plan to bring to the deal, and the exit options. The only thing that investors should be mindful of is regulations and currency – for non-US deals, sometimes exchange rate drag of the local currencies can eat into your returns if not appropriately planned for.
As an LP who also does direct investments, how has your return performance in Southeast Asia been? And what’s your take on the general PE performance in this region?
Historically, the industry was small, and exit avenues were fewer. IRR by very nature is dependent on the time horizon so the returns were more muted. As exit avenues have expanded, aided by the maturity of managers, the more recent vintages are doing very well. I’m not at liberty to disclose what our performance is, but it’s strong enough that we remain interested in putting more capital into the region.
Moving to a big picture question on China. After super-charged growth, first, there were trade tensions with the US, and now we are seeing increased scrutiny and regulations in the tech sector. In your view, will we see a shift in the flow of capital towards Southeast Asian nations?
Global capital is looking towards higher growth markets, and Southeast Asia stands out. Even Chinese investors are becoming an active part of the Southeast Asian ecosystem. The recent China situation is new, but I don’t think people are going to stop investing in China. There may be further caution around assessing the Chinese market risks, but let’s not forget China is a giant economy and has a large and thriving private equity and venture capital market. Adams Street still believes China is a very attractive market. We believe that even in all these situations, the quality of general partners is very crucial in navigating through markets and China has plenty of such experienced and successful managers.
There is an inherent interest in Southeast Asia given its large market, growth potential and industrialised economy but it just needs more on-ground validation. The maturing market and ecosystem offer ample opportunities to investors in terms of investment strategies. At the end of the day, investors will only commit capital if they feel that appropriate returns are being generated, not just because they’re choosing one market over another.
What should Southeast Asian markets learn from what’s happening in China?
China is a very different market than any other Asian or emerging market. I think as companies become larger, they need to understand how they are operating within policy guidelines. Are they being overly aggressive in sales and finance practices, are they overseeing employee benefits properly, or are they handling user data appropriately?
When fund managers invest in emerging markets like Southeast Asia, they should try to understand the industry dynamics and regulations of the particular country they are investing in. Nobody can predict a black swan risk – it’s hard to plan for that except for having some diversification in your portfolio. However, understanding regulations and the implications of regulations is important in our business. Many of our general partners in many of the Asian countries are cautious about heavily regulated sectors because sometimes these risks can be quite binary in nature.
Another issue that has been discussed more in the PE industry is ESG. Within Southeast Asia, what elements of ESG do you think will work best?
ESG has always been a subtle aspect of business and investment under corporate social responsibility. Around the mid-2000s, UN-led studies in ESG, which cumulated into what is known as Principles of Responsible Investment, of which Adams Street is a signatory. Since then, ESG has become a larger focus by the business and investment communities, and it has got a boost with the pandemic. There is a higher level of awareness of ESG, starting right at the base with our clients, up through to fund managers, and reaching businesses and portfolio companies. ESG isn’t just about compliance – although it’s very clear investors understand the benefits (and necessity) of good compliance and governance practices.
In the context of Southeast Asia, private equity has always been very focused on governance. Without it, it is difficult to ensure proper alignment and value creation. However, social and environmental factors are also being given due importance now with higher awareness. Recently Bain reported that Southeast Asia’s sustainability requirement offers a potential for a trillion-dollar annual economic opportunity by 2030. This includes both environmental and social aspects.
Will ESG investments improve returns for private equity funds?
Absolutely. This correlation has always existed, not as widely documented but there have been several studies by many institutions and academics, mostly focused on public markets, that underscore the importance of ESG compliance and better financial results. We always believe that private capital has to be ‘good’ capital – it has to create jobs, contribute to equality, and support the betterment of the society in which they operate. That’s why we have invested in technology and healthcare globally, even before COVID. In private markets, ESG is now a front-and-centre conversation. The cost of non-compliance is becoming high these days with several listed companies losing significant portions of their market cap when found lacking it. The benefits of adhering to stringent ESG standards are pretty obvious in private markets. For example, global strategics are always ready to pay one or two turns higher multiples for businesses that are well-performing but also compliant on all relevant ESG metrics.